The following is a fictional balance of payments accounts of a country labeled Surplus Land, which pegs its exchange rate to the dollar and controls the inflow and outflow of its capital....

 

The following is a fictional balance of payments accounts of a country labeled Surplus Land, which pegs its exchange rate to the dollar and controls the inflow and outflow of its capital.

Merchandise Exports                        100 billion Yuan

Merchandise Imports                        -50 billion Yuan

Service Exports                            5 billion Yuan

Service Imports                            -20 billion Yuan

Net Transfers                              -2 billion Yuan

Net Long Term Capital                      20 billion Yuan

Net Short Term Capital                     -3 billion Yuan

Net Change in Surplus Land’s Reserves      -50 billion Yuan

 

1) What are Surplus Land’s trade balance, net exports, current account balance, capital account balance, and official settlements balance?

2)What is the source of Surplus Land’s current account imbalance? How is Surplus Land financing its current account imbalance? Is Surplus Land’s international position sustainable? Explain. Why might Surplus land be reluctant to let its currency float?

Expert Answers
pnrjulius eNotes educator| Certified Educator

(1) There are a lot of terms to keep track of, but once you know what each of these things is, it's simply a matter of adding up the proper columns.

Trade balance is the same thing as net exports, and is calculated as exports minus imports (here they already gave us imports as negative numbers), including both goods and services:
100 billion yuan + 5 billion yuan - 50 billion yuan - 20 billion yuan = 35 billion yuan

Current account balance is net exports plus net transfers:
35 billion yuan - 2 billion yuan = 33 billion yuan

Capital account balance is net return on foreign capital plus net change in foreign reserves:
20 billion yuan - 3 billion yuan - 50 billion yuan = - 33 billion yuan

Notice that the following balance of payments equation holds:
(capital account balance) + (current account balance) = 0

In theory, this should always hold. In the real world, sometimes errors or hidden assets cause the two figures to be different, but for Surplus Land we have perfect figures so the identity must be exact.

The official settlements balance is the same as the net change in foreign reserves:
- 50 billion yuan

(2) Surplus Land's current account imbalance comes from their high net exports--their trade surplus, hence the name. They are selling more goods than they are purchasing, and thereby increasing their stock of money.

They are financing this current account surplus with a capital account deficit, which in this case means depleting their foreign reserves.

This is not sustainable, because eventually they're going to run out of reserves. When that happens, they'll have no choice but to let the currency float so that it can rise in value and cancel out the trade surplus.

They may be reluctant to do so, however, as for the time being this trade surplus allows them to take in more money than they are paying out, which directly increases their GDP, and could be used to support a fiscal deficit without government debt.

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